By Tiernan Ray

Shares of Extreme Networks (EXTR) are down a penny at $5.53 despite an upbeat note from Simon Leopold of Raymond James, who started coverage of the stock with an Outperform rating, and an $8 price target, writing that the company may have upside in a number of places, including its acquisition of Enterasys, deals with telecom providers such as Ericsson, and forthcoming products such as its “core” network switch.

“We envision several opportunities for upside,” writes Leopold:

Extreme partners with China-based Lenovo providing switches for Lenovo’s new converged infrastructure business. Timing is uncertain, but Lenovo’s plan to buy IBM’s low-end x86 server business implies Lenovo is committed to competing for enterprise business. We believe prospects from a partnership with Ericsson seem more promising given its new target of growth from IT services. Enterasys’s WLAN products combined with Extreme’s BlackDiamond X8 Core Switch offer performance metrics that we doubt investors appreciate.

With prospects for growth picking up in theExtreme’s traditional ethernet switch market, Leopold likes the increased share and the potential synergies that come with the Enterasys deal:

The combination of Extreme and Enterasys was a logical pairing, as they both share an uncanny number of similarities, yet have key differences. We envision synergies that make the stock an attractive value. Because networking equipment plays a critical role in the infrastructure of enterprises, the Ethernet switch market has intrinsically been sticky. History has shown that it is not difficult for small networking vendors to maintain an entrenched position with their customers once they have established an installed base. Infonetics tracks 17 switch vendors holding 3% or less of the market. Because of this dynamic, we envision the new Extreme as at least maintaining its new larger share, with the credible potential to grow it. Extreme was able to effectively double in size through the acquisition, which in our view would have cost much more to achieve organically than the $180 million price paid. Extreme acquired Enterasys from private equity firm Gore Group, who acquired Enterasys for well over $300 million in 2006. Nearly Identical Product Sets With Minimal Customer Overlap From a business and product standpoint the two companies offer virtually identical product sets, with Enterasys bringing over its chassis-based K and S series and its stackable solutions which include the top- of-rack 7100 series and campus edge A-C series. The similarities also extend into the wireless realm, with Enterasys’ own portfolio of wireless access points and controllers. Despite the product overlap, management notes that there is also virtually no customer overlap, which could allow Extreme to realize cross selling opportunities once the product lines are integrated and streamlined. Cost Synergies Management has targeted annual cost reductions of $30-40 million through a combination of manufacturing synergies, as well through reductions in operating costs. With Extreme now essentially doubling in size, and given that the portfolios of both companies are nearly identical, we see these targets as reasonable through the leveraging of purchasing power and scale. The synergies affect the model gradually over time, with the final elements as late as 24 months after the deal closed.

Leopold also sees upside if Extreme can expand into selling to cloud computing data centers:

Our Extreme investment thesis is not based on growth, so an element such as exposure to faster growing datacenter switches presents a prospect for better-than-modeled growth. Historically, Extreme sold about 15-20% of its switches into datacenters while Enterasys sold nearly none, with the balance going into campus application. Considering the favorable product reviews we have read for Extreme’s datacenter platform, we consider this an under-appreciated aspect of the company’s prospects. According to Infonetics, the Ethernet switch market is expected to grow 6% in 2014, to nearly $22 billion. This market can be split into $8 billion, or 38% of the market, in data centers growing at 10% in 2014 vs. $13 billion, or 62%, in the campus environment growing at 4% in 2014. The Ethernet switch market dynamic has led Extreme to expand strategically to more favorable end markets, particularly into datacenters. Although the datacenter market is significantly smaller at $7.6 billion, within the Ethernet switch market, which was $20.4 billion in 2013, according to Infonetics, growth is expected to be higher at 10% vs. 6% in 2014.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.